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New Law Raises the Bar for Audit Quality

Louis Grumet

The accountancy reform act signed into law by New York Governor David Paterson on January 27, 2009, will lead to major changes in the way New York accounting firms undergo peer review. Beginning January 1, 2012, firms with three or more accounting professionals and firms of any size that perform attestation services for government entities will be required to undergo a “quality review” on a triennial basis.

The NYSSCPA is pleased with the passage of the new law. The increased level of regulation should bring improved consumer protection and enhanced confidence in the auditing profession.

Peer review is not a new concept for the 1,800 or so firms in New York that participate in the AICPA's voluntary program. While statewide mandated review will be similar, there will be several important differences.

New York will be joining 44 other states and jurisdictions where peer review is mandatory. Presently, a New York accounting firm that does not wish to undergo peer review can simply opt out of AICPA membership. Under the new law, however, New York can revoke the registrations of firms that are legally required to undergo a review once every three years but fail to do so.

Quality reviews evaluate a firm's attestation services and quality control systems. To be effective, reviews should evaluate the tone at the top, auditor independence policies, client review and acceptance policies, and other areas that can affect the quality of an audit. Individuals in supervisory positions should be interviewed and all firm professionals subjected to competency standards. Small firms that are not required to undergo quality reviews can still participate in the program on a voluntary basis.

A Better Model

A 2005 Quality Enhancement Policy Committee white paper approved by the Society's board of directors found several potential weaknesses with the existing, voluntary peer review process. One weakness is how firms select reviewers. Under the current system, a firm selects and pays its own reviewer. Although firms cannot review each other, triangular review relationships could develop, creating the potential for independence and objectivity problems. The establishment of a state-certified list of reviewers from different firms—a requirement under the new law—could provide the mechanism to eliminate firm-on-firm independence issues. A similar model works quite successfully in the world of academia for the accreditation of educational programs, where a team is pulled together from a list of qualified reviewers and then disbanded once it completes its site visits and submits a report. It's too soon to say what form the state-certified list of reviewers of CPA firms will take, as officials are currently developing regulations to implement the quality review program.

Quality reviews will be filed with the New York State Board for Public Accountancy, an advisory board to the State Education Department (SED). The SED will periodically assess the effectiveness of the quality control program, as required under the new law. Quality reviews will be confidential, unless admitted into evidence during an SED hearing. The review would then be considered a public record, subject to disclosure under the state's freedom of information and personal privacy protection laws.

New York will honor peer reviews conducted in another state as long as the state's review process is deemed “satisfactorily equivalent” to New York's. State regulations, which are in the process of being written, will set standards for equivalency.

Other details of the program will eventually be determined through regulations as well, and Society leaders have been providing SED officials with input. Among these items is the implementation of disciplinary measures.

These regulatory changes have been a long time coming; the Society has been pushing for reform for 10 years. New regulations are necessary to keep pace with the accounting profession in a rapidly changing marketplace, where quality audits are vital to the investing public and third-party users of financial information. The last major reforms to the state accountancy law were made in 1947. As you know, much has changed since then, particularly with regard to the growth of CPA tax practices and financial and management advisory services. Under the new law, which takes effect on July 26, 2009, these services will be regulated by the state for the first time.

I hope that quality review will be embraced as an opportunity for accounting professionals to learn from each other and improve upon best practices. More importantly, such quality reviews will go a long way toward helping to reassure the public during these very uncertain economic times.

Louis Grumet. Publisher. The CPA Journal, Executive Director, NYSSCPA, lgrumet@nysscpa.org.

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